CWS Market Review – January 29, 2016

“The first principle is that you must not fool yourself,
and
 you are the easiest person to fool.” – Richard Feynman

We’re in the heart of Q4 earnings season. We had six Buy List earnings reports this week, and another four are due next week. In reality, this should be called “Judgment Season” because this is when the market renders its verdict, and the market gods can be quick and harsh.

The good news is that all eight of our Buy List earnings reports so far have topped expectations. The bad news is that guidance hasn’t always been favorable.

The worst news is that one of our new stocks, Alliance Data Systems (ADS), got crushed for a 19% loss on Thursday. I’ll have full details in a bit. But some of our stocks have done quite well. Biogen (BIIB) and Stryker (SYK) got nice boosts from their earnings. I’m also pleased to see that Microsoft (MSFT) had another solid quarter. Just a few years ago, many had written off the company.

This Week’s Buy List Earnings Reports

We also had a Federal Reserve meeting this week. As expected, Yellen & Co. held off on any rate increase, but the policy statement indicated that the Fed is still expecting more inflation and possibly more rate hikes to come. Wall Street is skeptical and so am I.

It’s quite remarkable how much the outlook has changed in just a few weeks. Not that long ago, investors were expecting three or four rate increases from the Fed this year. Now that’s down to one, or maybe zero.

The yield on the two-year Treasury is a good proxy for what the market thinks the Fed will do. The two-year yield is now down to 0.83% which is a drop of 26 basis points in one month. In other words, the market thinks the Fed is all talk.

Frankly, it’s not hard to see why. Plunging oil and the strong dollar are holding back inflation. In short, they’re doing the Fed’s job for them. Some of the recent economic data, especially on manufacturing, has been sluggish. While earnings are mostly good, we’re still seeing the effect of the strong dollar on corporate profits. Like I said, the market’s verdict can be quick and harsh.

In the near-term, I think the market will continue to be choppy. Further out, however, the outlook is still favorable for investors. As always, investors must be disciplined and focused on high-quality stocks.

This week was a busy one for earnings. Let me run down the six Buy List earnings reports we had. On Tuesday, Stryker (SYK) reported Q4 earnings of $1.56 per share. That wasn’t much of a surprise. A few weeks ago, the company revised their guidance to a range of $1.53 to $1.56 per share. When a company gives a tight range like that after the quarter has ended, you can be pretty sure that they’ll hit the upper end.

Like everybody else, Stryker was hurt by the strong dollar. Quarterly sales grew 3.7% to $2.7 billion, but it would have been 7.0% in constant currency. Sales for the year rose by 2.8% to $9.9 billion. Again, that’s 7.0% in constant currency.

“With 2015 organic sales growth of 6.1%, bolstered by a strong fourth quarter increase of 6.4%, our top line results came in above our initial guidance,” said Kevin A. Lobo, Chairman and Chief Executive Officer. “This performance reflects the strength of our diversified revenue model, a commitment to innovation and the competitive advantage of our sales and marketing organizations. Our full year adjusted diluted EPS also exceeded our initial expectation, underscoring our commitment to delivering sales growth at the high end of med tech and leveraged earnings gains. With these results and the current momentum across our businesses, we feel well positioned heading into 2016.”

For all of 2015, Stryker made $5.12 per share. That’s up from $4.73 per share last year. Just for the record, let’s remember Stryker’s guidance for this year. In January, the initial guidance was $4.90 to $5.10 per share. Then in April it went to $4.95 to $5.10 per share. In July, Stryker brought it up to between $5.06 and $5.12 per share. In October, they raised the low end by one penny per share. A few weeks ago, they raised the low end by another two pennies.

Now for guidance.

We expect 2016 constant currency sales growth in the range of 5.0% to 6.0% and adjusted net earnings per diluted share to be in the range of $1.17-$1.22 and $5.50-$5.70 for the first quarter and full year. If foreign currency exchange rates hold near current levels, we expect net sales in the first quarter and full year of 2016 to be negatively impacted by approximately 1.1% and 1.0% and adjusted net earnings per diluted share to be negatively impacted by approximately $0.02-$0.03 and $0.12-$0.13 in the first quarter and full year.

That’s pretty good guidance, but the dollar will continue to be a factor. I urge investors not to be too concerned by transient factors like currency exchange. Sometimes currency exchange helps you, sometimes it hurts. The bottom line is that this was another solid year for Stryker. Here’s the annual EPS trend for Stryker: $2.95, $3.33, $3.72, $4.07, $4.23, $4.73, $5.12. And now the expectation is for $5.50 to $5.70 for 2016. That’s very impressive.

The shares briefly topped our $101 Buy Below price before settling back down. For now, I’m going to keep our Buy Below at $101 per share.

On Wednesday, Biogen (BIIB) reported Q4 earnings of $4.50 per share which beat Wall Street’s consensus by 42 cents per share. The stock soared and at one point, BIIB was up as much as 10%.

This was a good report for a beaten-down stock. Sales rose 7.5% to $2.84 billion. For so much of last year, Biogen had to weather several terrible headlines. In October, the company said it was planning to lay off 11% of its workforce. The cost cutting, while painful, is clearly helping Biogen. For all of 2015, Biogen earned $17.01 per share which represents a 23% increase over 2014.

Here’s something interesting: The company is now sitting on a mountain of cash. They appear to be stockpiling Benjamins so shareholders can expect either a major buyback announcement or possibly an acquisition deal. Stay tuned for more news about this.

For 2016, Biogen said it expects earnings to range between $18.30 and $18.60 per share. Wall Street had been expecting $18.45 per share. I like the stock, but it might take some time to see gains here. It’s not so much the company but the broader environment for biotech. Either way, we know that Biogen is doing well. I’m dropping my Buy Below on Biogen to $290 per share.

On Thursday, Ford Motor (F) reported Q4 earnings of 58 cents per share. That beat consensus by seven cents per share. Frankly, there wasn’t much in this report that was unexpected. For the year, Ford had a pre-tax profit of $10.8 billion. Revenues rose 12.1% to $37.9 billion which beat estimates by $36.27 billion. The automaker will pay out a profit-sharing bonus of $9.300 per employee. Not bad.

Chief Financial Officer Bob Shanks maintained the Dearborn, Mich., auto maker’s forecast for equal or higher operating results in 2016, saying the company’s operations outside the U.S.—representing only a fraction of the auto maker’s profitability last year—are set to blossom.

“This isn’t just a North America story,” Mr. Shanks said, referring to last year. “We really started to see the international markets come forward.”

I think these are pretty good numbers but Wall Street wasn’t much impressed. The shares fell as low as $11.20 on Thursday before moving up before the closing bell. Some folks on Wall Street are convinced that the auto cycle has peaked and that Ford’s earnings and margins will suffer from here. They think the big special dividend was further proof of that.

Ford remains optimistic. They said they expect to earn a pre-tax profit this year in the upper half of their previous range of $10 billion to $11 billion. I know Ford is exasperating to own, but the numbers are still good. Don’t give up on them; and the dividend is quite generous. I’m lowering my Buy Below on Ford to $13 per share.

Now let’s look at this week’s troublemaker. For the record, Alliance Data Systems (ADS) beat earnings by two cents per share. Yet the stock fell by 4,780 cents per share or 19.4%. Ouch!

My apologies if you own this one. I know it’s painful, but these are the risks of investing. Still, there’s a lot to like here and we’ve gone through many similar declines over the last ten years.

Quarterly revenues rose 17.7% to $1.75 billion which was $40 million below estimates. For the whole year, ADS earned $15.05 per share, and that doesn’t include a 46-cent haircut due to currency. Wherever you look, you see the effect of the dollar.

But the real damage was their estimate for Q1. ADS sees earnings of $3.83 per share for this quarter. Adjusted for currency, that would be $3.93 per share. Wall Street had been expecting $4.14 per share.

But here’s the important fact: ADS stands behind its previous estimates of $17 per share for full-year 2016 earnings. There’s absolutely no change here at all. That means the stock is going for less than 12 times this year’s earnings. Let me caution you not to panic about ADS. A lot of the hot money ran for the exits but the long-term is on our side. To reflect the sell-off, I’m lowering my Buy Below on Alliance Data Systems to $225 per share.

After the closing bell on Thursday, Microsoft (MSFT) reported another solid quarter. I’ve been very impressed with the job Satya Nadella has done here. For their fiscal second quarter, the software giant earned 78 cents per share compared with Wall Street’s estimates of 71 cents per share. Revenue rose to $25.69 billion, $440 million more than consensus.

I don’t think people realize how much Microsoft has changed. As expected, the PC market was very weak, but that’s not where MSFT’s success has been.

Microsoft’s cloud business encouraged investors. The company’s intelligent cloud group, which includes its Azure service, rose 5 percent to $6.3 billion. It now has 20.6 million consumer subscribers to Office 365, the cloud version of its productivity applications, up from 9.2 million a year earlier.

I’m very happy with these numbers. For now, I’m keeping my Buy Below on Microsoft at $58 per share. Look for a new all-time high soon.

Finally, CR Bard (BCR) reported earnings of $2.43 per share which beat estimates by two cents per share. Earlier the company had told us to expect earnings to range between $2.38 and $2.42 per share. Sales came in at $870.8 million which was basically flat from a year ago, but adjusting for currency, sales were up 3%.

For the year, Bard made $9.08 per share. That’s a nice increase over the $8.40 per share they made in 2014. I’m going to keep my Buy Below for CR Bard at $204 per share, but I may adjust it soon, depending on the market’s reaction.

Four Earnings Reports Due Next Week

Next week will be another busy one for us. Let me preview next week’s earnings reports.

On Monday, AFLAC (AFL) is due to report Q4 earnings. The story for the duck stock has been a familiar one. Business is going well, but the weak yen has chomped earnings. The company has also been giving back a lot of money to shareholders. Buybacks have reduced their share count. AFLAC also recently raised their dividend for the 33rd year in a row.

In October, AFLAC said that if the yen stays between 120 and 125 on the dollar, then they expect Q4 operating earnings to range between $1.36 and $1.56 per share. That translates to a full-year range of $5.96 to $6.16 per share. The yen is currently at 119.

On Tuesday, Fiserv (FISV) will report earnings. Three months ago, Fiserv raised their full-year guidance to $3.84 to $3.87 per share. That range implies Q4 earnings of 98 cents to $1.01 per share. This should be their 30th year in a row of double-digit earnings growth.

A Snap-on (SNA) truck drove past me the other day. Maybe it’s a good sign. In any event, this is a very good company. Wall Street expects Q4 earnings of $2.18 per share which would be a 10% increase from the year before. I’ve highlighted the stock in the past few issues as being especially attractive. Don’t let these boring stocks fool you.

Stericycle (SRCL) is another one of our new stocks this year. Similar to ADS, this one got crushed by 19% after the last earnings report. The company blamed—wait for it—the strong U.S. dollar. Management also blamed lower hazardous waste volumes. Stericycle said they expect earnings for this year to range between $5.28 and $5.35 per share.

One final note. Shareholders at Hormel Foods (HRL) approved the company’s 2-for-1 stock split. The split will take effect on February 9. Don’t be alarmed when you see the lower share price because you’ll have twice as many shares. I’m raising the Buy Below to $82 per share, so after the split, the Buy Below will be $41 per share.

That’s all for now. Stay tuned for more earnings reports next. We’ll also get some of the key turn-of-the-month economic reports. The ISM report is due out on Monday. The last few have been quite weak. On Wednesday, ADP will release its private payrolls report. That leads us up to Friday’s jobs report. The unemployment rate could dip below 5% for the first time in eight years. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by Eddy Elfenbein on January 29th, 2016 at 7:08 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.